Corporate Welfare

Every Man a Jed Clampett

How to speculate on oil without getting your hands dirty


It will not escape the notice of astute readers that heavier-than-air flight requires a fair amount of energy. As a consequence, oil takes up a pretty big chunk of most airlines' operating budgets. So alarms should go off when normally oppositional, hyper-competitive airline companies suddenly join forces, urging all of their frequent flyers to write to their representatives in Congress to Stop Oil Speculation Now!

"Twenty years ago," says a letter [PDF] signed by dozens of airline execs and blasted into thousands of frequent flyer inboxes, "21 percent of oil contracts were purchased by speculators who trade oil on paper with no intention of ever taking delivery. Today, oil speculators purchase 66 percent of all oil futures contracts."

Sounds bad, right? "A barrel of oil may trade 20-plus times before it is delivered and used," the airline execs warn. Greedy speculators manipulating oil prices just by pushing paper around? Just who are these speculators, callously driving up oil prices and "hurting our families"? Well, for starters, the airlines themselves.

For years, the stunning success of Southwest Airlines has been a staple feature story on the business pages of major newspapers. In an era of rising prices and busted planes, Southwest seems to float above the fray. Even as the bottom lines of their airborne brethren fall ever lower—other airlines reported a collective $6 billion loss this quarter—Southwest is reporting its 69th consecutive profitable quarter. Tickets are still pretty cheap, and there are no new surcharges for checked bags, something the company has been making much of in its ads.

Southwest itself credits its profitability to savvy, forward-looking commodities hedging to compensate for higher fuel prices. In fact, the company has saved about $3.5 billion with hedging since 1998, a figure equal to 83 percent of its profits over that time. Hedging means that a company locks in a price for oil at a fixed date in the future by signing a contract today promising to buy the oil at that price, no matter what happens to the market in the interim. If prices go up, Southwest speculators get to buy below-market rates. If prices go down, they have to pay more than their competitors for the same oil.

"When oil got to $40 a barrel, we thought, 'Oh, wow! It's too late.' Then it went to $60, and to $80, and then to where we are now," Southwest Treasurer Scott Topping told USA Today this week. Topping is in charge of Southwest's hedging operations. "At each step along the way, the question 'Is this something we should continue to do?' became more and more difficult to answer. But our overall philosophy led us to keep buying hedges. It's a matter of discipline." Southwest has hedged so well that the company paid about $2.35 a gallon for jet fuel this quarter. Those with less speculative skill would have had to cough up $3.95 for the same gallon on the spot market.

Southwest, which also signed the Stop Oil Speculation spam, isn't the only airline to hedge on the price of oil?they all do, just not nearly as successfully. Apparently, when airlines buy oil futures on a bet that the prices will eventually go up, it's good business practice, but when people who don't happen to be the treasurers of airlines do the same thing, it's "rampant speculation" that "upsets the natural relationship between supply and demand."

And then there's that other greedy speculator: You. Anyone with a 401(k) or some kind of retirement benefit coming to them probably has a portfolio containing commodities futures, which are increasingly appealing as the dollar falls and the real estate market continues to reel. Or perhaps you own a bit of Southwest stock, which has a pleasing price these days. Futures contracts exist for all kinds of commodities, and the logic is always the same. It's similar to buying stock, or even buying a house. You're hoping to make a smarter bet than the other guy on which way the prices are going to go. It's how markets work. If there were no "speculators," you'd have no 401(k) and airlines would have to change prices every time Hugo Chavez managed to get ahold of a microphone.

The main concern about speculation, and the reason that the trading of many commodities (like onions, for instance) is regulated, is fear that one company might corner the market. Historically, most efforts to corner markets fail, so the danger of prices skyrocketing after a successful attempt is minimal to begin with. But the fear of futures contracts, or speculation, is even more absurd when the commodity is oil. The energy markets are international and incredibly dynamic. Congress can't really prevent people from speculating on commodities in London or Dubai, no matter how much it would like to, so speculation will carry on, affecting the prices Americans pay for oil, whether or not the bet is placed on our shores. A bill that looks a lot like the airlines' list of demands is currently stalled in the Senate, but it came close to passing earlier this week.

It's possible that no amount of speculation will make much of a dent in the price of oil, at least compared with the ever-growing demand for oil from India and China. In their letter, the airlines claimed that "current prices reflect as much as $30 to $60 per barrel in unnecessary speculative costs." But on Wednesday, a task force from the Commodity Futures Trading Commission found that "preliminary analysis to date does not support the proposition that speculative activity has systematically driven changes in oil prices."

And last month in The New York Post, reason contributor Alan Reynolds pointed out that since oil hit $100 a barrel, the number of speculators betting that the price will drop has increased dramatically. There are nearly as many traders who now think oil prices will fall as there are who think the price will rise. If prices keep going up, these guys are screwed. They're rooting for prices to go down, just like the rest of us, albeit for different reasons.

Frequent flyers are used to receiving all manner of useless promotional emails. "Fly to Siberia via Cincinnati and Rotterdam for only $363 one way!" The only difference is that the Stop Oil Speculation Now! email is worth little more than a stroke of the delete key. Compared to that, a trip to Siberia might actually be fun.

Katherine Mangu-Ward is an associate editor of reason.

NEXT: 'How much would a gallon of milk cost tomorrow, in Chicago, if the dairy subsidies were eliminated today?'

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  1. About a week ago, our local all news radio station, WTOP, followed a breathless story on how evil speculators were driving up the price of oil with a breathless story on how the cost of metro fares would soon rise due to locked in contracts (at $2.70/gallon) expiring.

    It didn’t occur to them to wonder about the pain the evil speculators were currently going through in supplying the gasoline.

  2. Those bastards! The gall of them, making money off our insatiable appetites.

  3. Red Herring Alert!!!! Red Herring Alert!!!!

  4. I wonder what newspapers those people are reading. From an article in the Financial Times (Unfortunately, I cannot find the article), there is evidence that prices are rising for commodities that are not subject to speculation (I think it was tin), therefore speculation is not a very good scapegoat. Furthermore, the same article mentioned that regulating speculation does not preventing prices from varying wildly. (I think it was the onion). I can see why airline companies want to regulate it: they just want form a club of legit speculators and they want to be the only members. Unfortunately, I can see the average Joe and Jane agreeing to them without giving a thought. For those types of regulation, the only ones who are getting royally screwed are the consumers. But who does have the time to do a cost-and-benefit analysis on a regulation?

  5. Sadly many(most?) people are ignorant of basic economics and even more so of futures markets (I fully admit I have no clue about futures).

    The sad fact is that most people are afraid of what they don’t understand and are easily swayed into thinking something or someone is “evil” if they don’t comprehend all of the facts. Oil speculators and the oil futures market is no different.

  6. So why are all the airline speculators telling you to tell congress to stop the speculators? Because as large corporatiosn, they have the advantage of size. They have the legions of lawyers necessary to wade through the upcoming speculation regulations. They’re big enough to afford the pay spot prices if they have to, especially when the same regulations prevent small startups from entering the industry.

  7. From the LA Times: “The Commodity Futures Trading Commission on Thursday alleged that Dutch trading firm Optiver Holding manipulated trading in New York futures contracts for oil, gasoline and heating oil in March 2007 — and turned a profit doing so. The case comes a day after a CFTC task force issued its preliminary report on high oil prices and found no basis for blaming speculators.”

    Nice. I guess with “dozens of investigations” going on, it’s tough to get them all to line up with the wonkifications …

  8. It is typical of progressives to characterise invesments they don’t like as speculative. THe truth is all invemsnets are speculative; even government bonds speculate the debt won’t be repudiated and inflation will be low.

    What is odd is the airlines are promoting this view. Regulation won’t reduce prices, but may increase overhead, and volitality. The airlines may have some trading algorithm that performs well with high volatility, but those things tend to suffer from the problems depected in the movie pi.

  9. I think its a bit disengenious to call everyone using a market speculators in this sense. Southwest’s use of a Futures Market like this is what it was developed for. If SW played it better than American then that’s totally fair. Outsiders who will never actually take delivery of the oil combined with unsubstainable hedging levels is a distortion of that market.

  10. I thought this was an article about how I could get into the game, but it was an equivocation on “Speculate.”

  11. I agree with John, “..Outsiders who will never actually take delivery of the oil combined with unsubstainable hedging levels is a distortion of that market.”

  12. Conservatives are also whining about a need for more regulation on oil speculation, with the usual exceptions like Walter Williams being ignored…

  13. But the real question is… does demand for futures contracts affect the spot price of oil. And my sense is that on a short term basis, the answer is yes, and on a longer term basis, no. That is charachteristic of markets in general. They make a lot of short term mistakes, are prone to groupthink and herd behavior, and can be subject to short term manipulation. After all, tech stocks and housing prices certainly weren’t basend on irrational exuberance.

  14. to whatever degree speculators push up prices in the short run…they also create additional incentives on the demand side to investigate ways to cut demand and on the production side to increase supply…thereby actuallly lowering longer term prices.

  15. ya gabe higher prices is acutally lower prices…nice try

  16. What should be the proper margin requirement for trading in oil futures? 1%? 50%? Or should the individual trading firms decide themselves what margin to require from their customers, if any at all?

  17. Research shows more oil drilling will lower prices
    Professor Morris Coates and another professor recently conducted a study to examine what the impact of opening up ANWR would be on today’s oil prices. Their conclusions speak for themselves:

    “We find that oil that is expected to reach the market some years hence has an immediate impact on oil prices,” and that “if oil firms were allowed to drill in ANWR and many of the other areas that are currently off limits to oil production, it is possible that these areas together might have a significant impact on world oil prices.”
    That is, “will lower prices.” When these two authors – both economics professors – submitted their findings for publications to a prestigious energy journal, what was the response from the rarified world of economists? It was rejection — but not for the reasons opponents of opening up new areas for oil and gas exploration would like to believe. No, their study was rejected because their conclusions were so obvious and so well-known – since the 1960s in the field of economics — that the two authors were not offering up anything new that merited publication.

    Letter from Energy Journal

    Although the referees, and I, are in agreement with your basic argument, I regret to say that we will not be able to publish this work. Basically, your main result (the present impact of an anticipated future supply change) is already known to economists.
    If Hotelling didn’t exactly spell this out in his original article, certainly Herfindahl and others had done so by the 1960s. It is our policy to publish only original research that adds significantly to the body of received knowledge regarding energy markets and policy.

    All the economists know it. How about distinguished Senator Maria Cantwell?

    How about the people of Alaska? Governor Sarah Palin says that developing ANWR would benefit them.

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